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Monday, 3 June 2013

Dynasties and reform

This article was published in The Malta Indpendent on Sundy - 02 June 2013

Commissioner Olli Rehn

The choices made by the PN delegates last weekend show that the dynasty culture is still alive and kicking within their Party. Electing a de Marco, a Fenech Adami and a Mifsud Bonnici to the top line formation looks dynastic.

One could argue that the new PN leader carries no such features and party inheritance-like appointments in the second and third line of authority do not really matter. They do. Dr Busuttil, as PN leader, has the odds stacked against him. He has to recover an electoral deficit of 35,000 votes and has to defy tradition where the electorate generally favours two-term governments. If Busuttil loses the next election it would be his second defeat. PN leaders rarely survive two successive defeats. Not even Borg Olivier did. Gonzi did not survive one. In such an eventuality, the dynasty looks set to prevail.

Reforms are what the EU Commission has recommended this week to most EU countries suffering economic instability or excessive deficits. This marks an evident shift from austerity to growth-oriented reforms. Recent statements from the Commission President that austerity policies had reached their practical limits of political acceptance set the scene for the change of strategy.

Unavoidably, Malta was re-admitted to the Excessive Deficit Procedure when the 2012 deficit again exceeded 3 per cent. It is the epitome of arrogance, a major cause of the PN defeat in the last election, to try to pin the excessive deficit that happened under their watch in 2012 on the new PL government. Arguing that the PL fudged the figures not only negates proven reality but insults the competence of the Permanent Secretariat at the Ministry of Finance, which is one of the few that survived the change of administration intact.

The new government asked to be permitted to come within 3 per cent during 2013. The Commission not only agreed but practically told the government to go slow on the adjustment and spread it over two years up to 2014. Contrary to when the bias was on austerity, the Commission demanded no expenditure cutbacks but made five specific recommendations for economic reform. They should be taken into consideration, even if not blindly adopted.

The first recommendation is not contentious and should find unqualified concurrence. Correcting the excessive deficit by 2014, keep pursuing neutral budget position by 2017 and achieving this mostly by enforcing tax compliance and fighting tax evasion to avoid the need for new taxation, has broad appeal. There is a further recommendation to reduce the debt bias of our corporate taxation. This ought to be disregarded. It does not take into account local realities, that most of our businesses are SMEs and micro organisations that do not have access to capital markets and rely on banks for external financing.

The second recommendation has several proposals regarding which both our political parties have drawn red lines. Accelerating and increasing the statutory retirement age and introducing an automatic link between retirement age and life expectancy is the sort of stuff that economists dream about. But from the political perspective, such measures are non-starters, certainly not in this legislature when the government manifesto carries specific pledges to the contrary. Other measures are more doable. Encouraging private pension savings, developing an active aging strategy, increasing access and reliance to primary health-care and improving the efficiency of public procurement procedures is what we have already been promised in Labour’s manifesto.

The same applies to the third set of recommendations. Reducing the number of education drop-outs at a young age, increasing the linkages between our education system and its relevance to the labour market, accelerating female participation in the labour market through the provision of child-care facilities and the promotion of flexible working arrangements could have been copied from Labour’s election programme.

Even the fourth recommendation is practically what Labour has promised us. Diversification of the energy mix and energy sources, the timely completion of the electricity link with the European mainland and the promotion of renewable energy, are all on the brief of Energy Minister Conrad Mizzi. The reduction of traffic emissions by making public transport the first choice for the majority of the population needs help from the other Mizzi in the Cabinet.

It is the fifth recommendation that needs some chewing upon. It concerns the stability of our banking sector and obviously draws a lot on the experience the Commission has had with the events in Cyprus.

It needs proper dissection and analysis. The recommendations are taken to refer to the five core domestic banks whose main activities are collecting deposits and granting loans to Maltese residents and who collectively hold assets equivalent to 200 per cent of the country’s GDP. In the in-depth review published by the Commission on 10 April, these five core banks are described as having “a rather conservative business model that relies mainly on resident deposits for their funding and have a low loan-to-deposit ratios, around 70 per cent. This combined with a stable deposit base, thanks to the high propensity to save of Maltese households, helped the core domestic banks cope with the financial crisis and the volatility on the international wholesale markets. The banks did not need government support nor did they resort to the ECB’s long-term refinancing operations to any significant degree to improve their liquidity”.

With such a certificate, which would be the envy of many other countries – even those that have not required bailouts – one is entitled to wonder why then the Commission is making recommendations for core Maltese banks to “strengthen the provision for loan-impairment losses… to mitigate potential risks arising from exposure to the real estate market”.
The reason for this is found in the report itself. “Since banks make provision against only the unsecured part of an exposure, the coverage ratio is relatively low at about 20 per cent (of the gross value of non-performing loans)”. In simple words, the Commission is telling banks not to rely on this security for recovery of non-performing loans, and to increase provisions more than the current 20 per cent cover.

In these turbulent days, one can never be over-cautious when it comes to protecting the stability of the financial system. We should desperately guard and be envious of what has saved us. Whilst most non-performing loans have solid security cover, advice to increase the provision coverage should not be dismissed lightly even if the Regulator would have to impose it on the operators and force them to moderate their dividend distribution policies until better coverage is achieved.

The fifth recommendation also includes a very relevant recommendation to “improve the overall efficiency of the judicial system, for example by reducing the time needed to resolve insolvency cases”. This criticism is more than fair.

Our bankruptcy laws are chronically out of date and desperately need up-dating so that banks can rely on quick resolution of cases of defaulting borrowers that can be re-organised and re-energised by Chapter 11 type of legislation. This forces debt write-downs or conversion into equity for businesses that are still feasible if re-organised with better financial gearing. For those business that are beyond repair, resolution through efficient bankruptcy proceedings is important for lending banks to make realistic reliance on their security and thus remove non-performing loans from their books following realisation of covering security.

No financial centre can thrive with mediaeval bankruptcy laws where litigation takes endless years to be resolved, as, for example, the ex-National Bank of Malta shareholders’ infamous case against the government.

Adopting the general spirit – if not the totality – of the recommended reforms is as important as correcting the excessive deficit.